Taking advantage of volatility in the market

The stock market is controlled by people and, as a result, emotions. The two most prominent of these are fear and greed. Under their sway, the market makes very little sense in the short term. On the slightest news of a sales decline or the first glimmer of hope in a clinical trial for a new drug, a company’s stock can plummet or skyrocket far beyond the ranges of reason and logic. The good news is, this volatility can make you very, very rich.

A stock market correction may be based on emotion, not logic

Presume there is a bookstore in New York City that you wish to purchase. The store sells $300,000 worth of books annually and is quite profitable. This particular bookstore is painted a light shade of blue. Each morning, the investment banker representing the current owners comes to your office and offers to sell you the property for what he believes it is worth on that particular day.

On Monday, he comes and offers to sell you the business for $500,000. You refuse; overpaying for a business. even an excellent one, is always folly. On Tuesday, he stops by and offers the store to you for $800,000 because he believe bookstores that are painted blue are on the rise. Once again, you send him on his way.

On Wednesday, however, the banker arrives at your office in a panic. Apparently, a number of students at a local high school began to burn books en masse and he is gravely concerned the bookstore business will soon have no value. As a result, he offers to sell you the business for $50,000. Realizing that it is completely illogical to assume a book burning is going to have any effect whatsoever on long-term profits, you readily accept the deal and buy the company for a fraction of its intrinsic value.

Well, I’d never get a deal that good! you might say. You are presented with them every day! When a company’s stock plummets, people often panic and sell. Unless the business is truly facing extinction or a drastic decrease in value, this is insane. If your favorite ice cream went on sale, would you wait until it had doubled in price before you bought it. Why should your favorite stock be any different? Coca-Cola is certainly more attractive at $20 per share than it is at $50 per share, regardless of any short term difficulties that may arise. An investor should feel no shame in exploiting the folly of Mr. Market .

Stock market corrections are filled with opportunities

True fortunes are made during times of economic distress or financial corrections. Only one year before he completed the formation of U.S. Steel (which financial historians have called the deal of the 20th century), J.P. Morgan said that such a feat could never be accomplished by any man — until the markets crashed. The depressed valuations of the companies involved allowed him to purchase the business entities at a fraction of what they had been selling for twelve months earlier.

The next time the market is cut drastically to its knees, look around for the great, solid, blue chip companies that have weathered depressions countless times before. The odds are substantial they will be selling at discount prices, and when the market finally does recover (which it inevitably will), your portfolio will profit from the shrewd, logical investment decisions you made while the investing public was in a panic. The secret to wealth has always been to buy when there’s blood running in the street and sell when everyone is pounding at your door, clawing to own your equities. You must have enough faith in yourself to buy when the rest of the market is selling. Most people don’t have the self-confidence and resolve to do so, and always end up following the crowd.

Remember, just because you follow the majority of people, doesn’t mean the majority of people aren’t wrong. That’s why 95% of investors aren’t driving Mercedes and living in Key West three months out of the year. Base your decisions on analysis and value and you will, more often than not, come out ahead.